The Stern Files (third edition)

Halloween may have been three days ago, but the bankruptcy world continues to be haunted by the Supreme Court’s decision in Stern v. Marshall, No. 10-179, 2011 WL 2472792 (U.S. June 23, 2011). Stern, like the Blob, has been oozing into case after case (120 cases at our last count). Don’t be caught off guard when it comes for you, read the Stern Files and be ready to defend your ground (see the first and second editions).

Background: Defendants in an adversary proceeding, seeking summary judgment, asserted that the trustee’s claims against them were barred by res judicata because they had received a favorable judgment in state court in another action brought by individual plaintiffs. The trustee’s claims were counterclaims asserted in response to defendants’ claims against the estate.Stern Impact: The court found that even if the trustee’s counterclaims were not within the court’s core jurisdiction following Stern, they would still “affect the extent of the estate” available for creditors, and, therefore, the court had “related to” jurisdiction. The court rejected defendant’s argument that 28 U.S.C. § 157 precluded including adjudications of estate counterclaims in related to jurisdiction by excluding enumerated categories of core jurisdiction from related to jurisdiction. The court argued that Stern’s remedy when adjudications of estate counterclaims violate the constitution is to remove those claims from the bankruptcy court’s core jurisdiction, and, therefore, the statute does not preclude such claims from inclusion in the bankruptcy court’s related to jurisdiction. The court held that its denial of the defendant’s summary judgment motion was “consistent with” related to jurisdiction because it “leaves the entry of ultimate judgment to the district court.”

Background: Plaintiff brought a post-confirmation complaint asserting a state law breach of contract claim. The court dismissed the action, concluding that under Ninth Circuit law, the bankruptcy court did not have subject matter jurisdiction.

Stern Impact: The court noted that defendants’ argument that Stern stripped the court of jurisdiction was misplaced, as the Stern decision addressed the issue of when a bankruptcy judge has the power and authority to enter final orders, but did not address subject matter jurisdiction under 28 U.S.C. § 1334. The court noted that even though Stern does not deal with questions of jurisdiction, it would dismiss the complaint because neither the bankruptcy court nor the district court had subject matter jurisdiction over the state law breach of contract claim.

Background: The debtor’s proposed chapter 11 plan called for contributions from certain non-debtor guarantors of debt owed to its primary creditor. The non-debtor guarantors sought releases in exchange for their contributions. Instead, the court imposed a four-year stay on any actions by the creditor against the non-debtor guarantors while the plan was effectuated. The creditor requested the court impose “lock-up” provisions over certain of the debtor’s assets to prevent them from disposing of them during the four-year stay. The debtor objected to the proposed lock-up provisions stating that, following Stern, the court lacked the constitutional authority to grant such provisions.Stern Impact: After a lengthy discussion of Stern, the court determined that the Stern holding was narrow in its scope and while the Supreme Court did limit the bankruptcy courts’ jurisdiction over state law counter claims, “nothing in the [Stern] opinion actually limits a bankruptcy court’s authority to adjudicate the other “core proceedings” identified in section 157(b)(2) [of the Bankruptcy Code].” Additionally, “[p]arties may, even after Stern, consent to bankruptcy courts entering final judgments in non-core matters.” Applying these holdings to the case before it, the court determined that the lock-up provisions were an integral part of the confirmation order and thus the court’s consideration of such terms “unquestionably” fell within the bankruptcy court’s core jurisdiction. Additionally, the court found that the non-debtor parties had “expressly and impliedly consented” to the entry of final orders by the bankruptcy court “by virtue of their controlling interest in the debtor as proponent of the plan.” As such, the court overruled the non-debtor guarantors’ objection to its consideration of the lock-up provisions.

Background: The matter arose out of the Petters ponzi scheme, which involved multiple entities. Some ended up in federal equity receivership and some ended up in bankruptcy. The equity receiver was also a trustee appointed in two of the bankruptcy cases, and he brought avoidance actions against the bank (among others) both in the bankruptcy court (founded at least in part on causes of action under the Bankruptcy Code) and in federal court (on behalf of an entity that was not put in bankruptcy). The bank argued that, to maximize efficiency and avoid potentially inconsistent results, it should not be subject to identical claims premised on the same facts in two separate courts and sought to the withdraw the reference from the district court to the bankruptcy court. It further argued that, after Stern, it was questionable whether the bankruptcy court could enter a final judgment in the actions brought in bankruptcy court. The district court denied the bank’s motion.Stern Impact:The court noted that the plaintiff’s claims brought in the bankruptcy court “appear to be quintessential core bankruptcy claims, including claims to recover preferences and fraudulent transfers.” The court referred to a pre-Stern opinion of the bankruptcy judge overseeing the actions finding federal fraudulent conveyance actions to be core, and finding that “‘the process of garnering fraudulently-transferred assets back into the bankruptcy estate . . . is one of those proceedings which is by its very nature essential to the adjustment and restructuring of debtor-creditor relationships that is at the core of federal bankruptcy jurisdiction.’”

The court stated that it recognized that the core/non-core distinction was for the bankruptcy court to determine under 28 U.S.C. § 157(b)(3), and that it was not confining the bankruptcy court’s determination on the question, but was considering the core/non-core distinction as one of several factors to decide the withdrawal motion. The court distinguished Stern, saying that estate counterclaims have “only a fortuitous relationship with the bankruptcy” and that the Stern issue arose after the bankruptcy court entered a final judgment, whereas in the present case the proceedings were at an early stage.

The court also found that considerations of judicial economy favored leaving the actions in the bankruptcy court for at least the pretrial phase. Any harm that could result from one of the actions being heard in the district court could be remedied with other devices.

Background: A chapter 7 trustee brought a complaint against the defendant under the Florida Consumer Collections Practices Act (FCCPA). In its answer, the defendant had admitted that the court had jurisdiction over the proceeding pursuant to 28 U.S.C. § 157(b)(2)(O). After Stern, and about two weeks before a trial was set to begin, the defendant filed a motion requesting that the court dismiss the action or abstain from hearing the matter.Stern Impact: The court held that the defendant’s re-thinking had come too late for it to receive the relief it sought, and that its reliance on Stern was misplaced. The court noted that Stern’s holding was “limited to precisely those facts” in that case, and that the Stern decision did not impact a bankruptcy court’s ability (i) to hear non-core matters and (ii) to decide them with the parties’ consent. Because the court had “related-to” jurisdiction over the FCCPA claims and the defendant had consented to the bankruptcy court’s deciding the proceeding, the court denied the defendant’s motion to dismiss.

Background: A chapter 7 trustee brought state and federal claims for fraudulent conveyance and state claims for unjust enrichment, and the defendant sought to withdraw the reference.Stern Impact: Reading Granfinanciera and Stern’s treatment of Granfinanciera together, the court found it “lack[ed] constitutional authority to enter final judgment on the claims presented here,” but that the Supreme Court “never suggested that bankruptcy courts could not otherwise hear those claims.” Rather, the Supreme Court “at least implied that the effect of its decision was to ‘remove’ certain claims from ‘core bankruptcy jurisdiction’ and to relegate them to the category of claims that are merely ‘related to’ bankruptcy proceedings and thus subject to being heard, but not finally decided, by the bankruptcy courts.”The court stated that its interpretation can be supported by either reading Stern (i) to remove claims from the bankruptcy court’s core jurisdiction when they would violate the constitution, and therefore leaving those claims in the related to jurisdiction category; or (ii) as forbidding bankruptcy courts from entering final judgment, but still allowing them to hear matters by reading the Stern Court as striking “and determine” from 28 U.S.C. § 157, as it pertains to certain matters. The court declined to determine which of these explanations is “proper” because they lead to the same result.

Background: The defendant challenged a judgment entered by the bankruptcy court (prior to Stern) on the basis that the judgment was void under Federal Rule of Civil Procedure 60(b)(4) and Federal Rule of Bankruptcy Procedure 9024 because the court lacked jurisdiction to enter the judgment following Stern.Stern Impact: The court found that, even assuming jurisdiction was lacking, under Fifth Circuit precedent, and similar precedent in other circuits, Rule 60(b)(4) cannot be used to attack a final judgment when the parties had the opportunity to challenge subject matter jurisdiction on appeal and did not do so, and the jurisdictional error is not “egregious” or a “clear usurpation of power.” Rather, a challenge to the court’s jurisdiction must be raised on appeal. In addition, the Fifth Circuit has held that even where the Supreme Court creates a new rule of law that must be applied retroactively, the rule may not be applied to cases in which judgment has become final.

Background: The bankruptcy court issued an oral ruling granting the trustee’s motion for substantive consolidation. After the oral ruling, certain creditors filed an objection to entry of the order approving that motion to consolidate. The court ruled that the objection was untimely and then turned to whether it had constitutional authority to issue a final order substantively consolidating the debtors’ estates.Stern Impact: The court stated that Stern must be construed narrowly and that bankruptcy courts have jurisdiction to make final determinations on all “core matters.” Because substantive consolidation “does not exist outside the context of a bankruptcy proceeding” and does not arise under state law, it is clearly a core matter and within the purview of the bankruptcy court, so the court had authority to enter a final judgment. The court further based its holding on the understanding that substantive consolidation is “premised upon the goal of a ratable fair distribution to creditors, which is one of the fundamental goals and purposes of the federal bankruptcy scheme.”

Background: In state court, plaintiff sought to set aside HSBC’s foreclosure sale of her home due to HSBC’s alleged violation of a section of the California Civil Code that requires that the assignee of a mortgagee record an assignment before exercising a power to sell real property. A California state court case (“Stockwell”), as well as the vast majority of case law, held that this section of the Civil Code does not apply to deeds of trust. Plaintiff was only able to cite one case to the contrary (from a bankruptcy court).Stern Impact: The state court disregarded the bankruptcy court case, noting that “holdings of the federal courts are not binding or conclusive on California courts, though they may be entitled to respect and careful consideration.” Citing Stern, the court noted, “a federal bankruptcy court’s decision interpreting California law, however, is not due the same deference.”

Background: The defendant filed a motion seeking a determination of the statutory and constitutional limits of the bankruptcy court’s jurisdiction over a proceedings initiated by the debtors in state court, prior to their chapter 11 filing, that was later removed to the district court and referenced to the bankruptcy court. The dispute centered on whether the debtor’s business violated a non-compete clause that the defendant had allegedly obtained right to enforce through a sale and purchase agreement prior to the bankruptcy.Stern Impact: The court held that it had subject matter jurisdiction and stated that Stern does not affect the subject matter jurisdiction of the bankruptcy courts. Additionally, the court held that Stern confirmed that a party can consent to a final judgment in a non-core matter as contemplated by 28 U.S.C § 157(c)(2), and that even absent consent, bankruptcy courts still have subject matter jurisdiction and can enter a report and recommendation.

The court pointed to another case from the 2011 Supreme Court term to support its holding. In AT&T Mobility, LLC v. Conception, 131 S.Ct. 1740 (2011), the Supreme Court “effectively held” that a final decision could be rendered by an arbitration panel if the parties to the arbitration had contractually agreed to binding arbitration. The bankruptcy court stated that “[c]ertainly if non-judges can enter binding decisions with the contractual consent of the parties, than bankruptcy judges ought to be able to enter final judgments in non-core bankruptcy proceedings where the parties have consented.”

The court determined that the claims at bar where core because if the defendants prevailed and were able to enforce the non-compete clause it would effectively terminate the debtor’s ability to operate as a going concern.

Background: Bankruptcy court dismissed a petition in intervention filed in a related adversary proceeding by the debtor’s principles against the primary creditor on the basis that the pleading did not satisfy the particularity requirement of Rule 9(b) of the Federal Rules of Civil Procedure. The principles’ petition was based on state law fraud claims. The principles’ appealed, arguing that the bankruptcy court did not have jurisdiction over their personal claims against the creditor.Stern Impact: The district court vacated the bankruptcy court’s order dismissing the petition. The district court also withdrew the reference to the bankruptcy court, noting that the issue on appeal was not one of jurisdiction, but one of constitutional authority, which the bankruptcy court lacked in this matter. The district court held that the matter was not “core,” but even if it had been a core proceeding, (i) ”a petition in intervention that asserts only state law claims … is not entitled to any greater bankruptcy status than the counterclaim filed by Stern in response to Marshall’s proof of claim” and (ii) the bankruptcy court did not have the constitutional authority to issue a final judgment regarding the petition.

Background: Defendants sought to have certain avoidance-type actions premised on state and foreign law remanded from bankruptcy court to state court, or to have the bankruptcy court abstain, based on the bankruptcy court’s putative lack of subject matter jurisdiction. The bankruptcy case was an ancillary case, under chapter 15 of the Bankruptcy Code, to a foreign liquidation proceeding in the British Virgin Islands (“BVI”). The debtor/plaintiffs were funds that invested with Bernard Madoff and became insolvent when the Madoff fraud was exposed, and through the actions were seeking to recover distributions made before the fraud was discovered. Initially plaintiffs brought state court actions for money had and received, unjust enrichment, mistaken payment, and constructive trust, but after commencing the chapter 15 they began removing actions filed in the state court to the bankruptcy court, filed additional identical actions in bankruptcy court, and amended the pleadings to add statutory claims under BVI law for preferences and “undervalue transactions.”The bankruptcy court found it had core jurisdiction over the avoidance claims in particular, and the actions as a whole because they affected the court’s “core bankruptcy functions under chapter 15.”Stern Impact: The district court reversed, concluding that the bankruptcy court lacked core jurisdiction because the cases did not “arise under” or “arise in” a title 11 case, and the assertion of subject matter jurisdiction by an Article I court offends Article III of the Constitution. Despite finding no statutory basis for subject matter jurisdiction, the court also found that the actions could not be heard by an Article I court. Specifically, it found that the claims asserted were matters of private right. It likened them to state contract claims brought to augment the estate, and rejected arguments by the plaintiffs that augmentation of the estate could serve as a basis for core jurisdiction.

Background: In 2006 Coudert Brothers sought bankruptcy protection under chapter 11. Six months later, the Retired Partners of Coudert Brothers Trust commenced an action in state court against “active” partners and the law firms they joined following Coudert’s failure. The Trust asserted state law breach of contract and tortious interference claims against the law firms and sought to impose on them successor firm liability. The law firms removed the action to the district court, which referred the matter to the bankruptcy court to be considered in conjunction with Coudert’s chapter 11. After the liquidation plan was confirmed, Judge Drain on the law firms’ motion, dismissed the Trust’s claims holding that it lacked standing to pursue the claims, as standing vested with the plan administrator.The Trust appealed Judge Drain’s dismissal to the district court. During briefing, the Stern decision was issued by the Supreme Court. In response, the Trust changed course and moved to dismiss the appeal and remand the matter to state court.Stern Impact: Judge McMahon stated that, following Stern, a bankruptcy court’s ability to make final judgment hinged on whether the claim involved a ‘public’ or a ‘private’ right. Judge McMahon held that the Trust’s claims involved private rights and thus the bankruptcy court did not have authority to enter a final judgment. Judge McMahon then turned to whether Judge Drain possessed final adjudicative authority by way of implied consent of the parties.

Judge McMahon stated that Stern confirmed “that consent can be a sufficient basis for Article I final adjudication,” but noted that the SternCourt had created some confusion regarding consent when it held that Pierce consented to having his defamation cause of action finally resolved by the bankruptcy court when he submitted his proof of claim, while at the same time holding that Pierce did not truly consent to having the counter-claim for tortious interference finally determined by the bankruptcy court.Judge McMahon stated that the apparent tension in the Stern holding “is resolved when one recognizes that the Court’s consent holding flows from its broader holding that the Bankruptcy Court may adjudicate not only public rights, but also any private rights necessarily resolvedin ruling on a creditor’s proof of claim.” Thus, while a creditor consents to all actions necessarily resolved in ruling on a proof of claim, that consent does not extend to claims not resolved by ruling on the proof of claim.

Following this logic, Judge McMahon concluded that because not all of the issues raised by the claims would be resolved in ruling on the Trust’s proof of claim, the Trust’s consent – via filing a proof of claim – did not extend to those actions.

This left Judge McMahon in what she termed “procedural morass;” unable to consider the merits of the Trust’s appeal because she was forced to vacate Judge Drain’s dismissal. Judge McMahon circumvented the issue by deciding to treat Judge Drain’s “final” determination dismissing the claims as a report and recommendation of dismissal.